A Short-Term Rally in 'High-Quality' Stocks May Not Be Over

Includes: AXP, EWBC, FCX, MTB, SPY
by: Stephen Castellano

While a "sell-the-news" reaction was widely expected following the FOMC announcement yesterday (see the Wall Street Journal for a good overview), "high-quality" long positions in our theoretical model portfolios finished higher for the fourth day in a row. We do not often pay such close attention to daily stock moves -- based on our ~1 to ~3 month holding period, we view most daily fluctuations in price as noise. But yesterday we did because we wanted to get a better understanding of what might be inferred by the new quantitative easing plan.

Leading our group of "high-quality" stock were two regional banks -- M&T Bank Corp. (NYSE:MTB) in our fundamental only Naive model, and East West Bancorp Inc. (NASDAQ:EWBC) in our other models. This is probably because the Fed's decision to focus purchases on Treasuries with maturities between five and six years suddenly drove near-term interest rates down and long-term interest rates up, making it easier for banks to borrow at low rates and lend at higher rates.

Inflation should hurt credit card companies since it reduces the value of liabilities, which may be why American Express (NYSE:AXP) finished down yesterday. Why then the price decline in Freeport McMoran (NYSE:FCX), which should benefit from inflationary pressures? Perhaps due to a decline in copper prices earlier in the day, purportedly driven by a positive ADP employment report. And stocks in general may have finished higher yesterday since inflation can raise reported earnings.

If any one useful thing might be inferred by any of this, perhaps it could be that there is a basis for a short-term rally in beaten-down bank stocks. If such a bank rally is at all sustainable, this could have a positive impact on other sectors as banks find the confidence to increase lending efforts. If the Fed is lucky, maybe it will pull back on its QE2 plan at the right moment and let fundamentals take over.

Having said all that, we do not allocate positions in any of our investment models based on any strategic or macro forecast. Instead, we select the "highest-quality" stocks for our long portfolios and use stock-specific and general portfolio return targets to manage our risk, such as with this long-only model based on actual trade data.

In any case, we do think there is a good case for remaining optimistic about a continued short-term rise in stock prices due to 1) expectations for rising inflationary pressure as aforementioned; as well as from 2) the sharply improving fundamentals of "high-quality" stocks that we mentioned in a Seeking Alpha article a few days ago.

Disclosure: Long EWBC, AXP, FCX